Outlook 2018 - Asia high yield bonds: Clipping coupons, careful selection

  • 21 Dec 2017

    Asian high yield bonds performed strongly in 2017. In 2018, I will continue to focus on bottom-up security selection, with a bias towards high quality issuers and liquid holdings, and a focus on income. An issuer and sector constrained approach remains key to ensuring diversification and managing volatility.

    What is your investment outlook for Asian investment grade bonds in 2018?

    Going into 2018, the various Asia market dynamics remains supportive for the Asian high yield market. Asian high yield has produced strong returns since beginning of 2016, thanks to improving credit profiles with better liquidity, and lower cost of funding, as well as strong technical drivers.

    As the Fed has started to reduce its balance sheet, sluggish inflation suggests that interest rates are unlikely take off drastically in 2018. However, as the larger global economies, specifically the US and the EU, continue to produce mixed signals, the longer duration asset classes could be more volatile in the future.

    The impact of this on Asian high yield bonds should be limited given their short duration and relatively high income.

    Furthermore, the structural improvements in China - namely, increasing credit differentiation, introducing an interest rate corridor, and the gradual liberalisation of RMB - are signs of a market evolution in the country.

    More generally over the past few years, the Asian high yield market has continued to grow in depth and breadth, with a strong domestic investor base and growing investment opportunities. These are positive developments which help mitigate event risks and shocks.

    Chart 1: China structural improvements - onshore credit differentiation

    Source: Bloomberg, Fidelity International, October 2017

    Chart 2: China structural improvements - controlled currency

    Source: Bloomberg, Fidelity International, October 2017

    Chart 3: China structural improvements - monetary policy mechanism

    Source: PBOC, Bloomberg, Fidelity International, October 2017

    What do you think could most surprise investors next year?

    Interest rate normalisation has been widely anticipated by the market for some time, but a faster US rate hike cycle could surprise markets and cause some volatility. However, short duration assets with high natural income will help reduce volatility compared to longer duration asset classes. Maintaining liquidity will help to take advantage of any buying opportunities as they emerge.

    Another possible surprise for investors is related to the widely expected China slowdown in 2018. However, the government stimulus effort in 2016 could potentially have a lasting effect on the economy, and support a longer period of moderate growth than many observers expect..

    This longer period of moderate Chinese growth is supported by the structural improvements in the financial markets as well as the transition of the economy from manufacturing to more service-based industries. The moderate yet higher quality growth can also provide a more sustainable economy for China in the long run, which also benefits Asian high yield.

    How do you plan to capture the best opportunities and add value for investors?

    Looking ahead, considering the relatively tight valuations, income is likely to be the main contributor to total return for Asian high yield in the near-term. I am continuing to focus on high coupon and short-dated instruments while defensively positioning at the short end, which helps support liquidity. As the short-dated instruments mature they allow reinvestment, and the ability to capture buying opportunities when they present themselves.

    A bottom up selection process with focus on idiosyncratic risks allows me to identify buying opportunities, such as from pockets of volatility, exogenous events, new issues and high quality unrated names.

    Finally, an issuer and sector constrained framework provides diversification within a growing opportunity set instead of concentration in capital intensive sectors.

    In terms of sector focus, consumption, retail and healthcare will be supported by higher discretionary spending and the pursuit of a better-quality life, as the middle-class continues to grow across many parts of Asia. Sectors like renewable energy and other environmentally related industries will benefit from an alignment of government policies.

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    BRYAN COLLINS is a portfolio manager based in Hong Kong at Fidelity International. He joined Fidelity in 2006 as a fixed income trader and became lead portfolio manager for Asian high yield in 2009. Prior to joining Fidelity, Bryan held a variety of roles in Credit Suisse Asset Management in Sydney, starting as a client consultant responsible for fixed income in 2000, before eventually becoming senior trader for fixed income and foreign exchange.